Pension reform is high on the policy agenda of many advanced and emerging market economies. In advanced economies the challenge is generally to contain future increases in public pension spending as the population ages. In emerging market economies, the challenges are often different. Where pension coverage is extensive, the issues are similar to those in advanced economies. Where pension coverage is low, the key challenge will be to expand coverage in a fiscally sustainable manner. This volume examines the outlook for public pension spending over the coming decades and the options for reform in 52 advanced and emerging market economies.

Pension systems vary widely across advanced and emerging market economies. Differences include (but are not limited to) the respective roles of the public and private sectors in ensuring retirement income; whether pension promises are financed on a pay-as-you-go basis or funded (Box 2.1); the legal retirement age for men and women; coverage; the existence and generosity of early-retirement plans; the generosity of the public plan as expressed for example by replacement rates; the existence of mandatory private pensions; and indexation rules. This chapter surveys key characteristics of current public pension systems in the 53 countries under consideration.

Public Pension Systems Include Old-Age, Survivor, and Disability Benefits

Old-age benefits account for about three-quarters of total pension spending. The remainder is accounted for by survivor benefits (10 percent) and disability pensions (15 percent). Although on average these shares have remained fairly constant over the past three decades, some countries have experienced substantial variation in the composition of pension spending. Increases in the share of disability pensions of 10 percentage points or more have occurred in Australia, Ireland, New Zealand, and the United Kingdom; there have been declines of similar magnitude in Finland, Luxembourg, the Netherlands, and Portugal. Such large swings reflect both economic conditions—claims for disability pensions tend to increase during economic slowdowns—and policy reforms, both of which can have persistent effects on pension spending and labor market participation.1 The importance of each of these programs varies across countries, to a large extent reflecting both the degree to which disability pensions are used as a pathway to retirement and the relative generosity of disability and old-age pensions (OECD, 2006). In Norway and the United Kingdom, where disability is often used as a bridge to retirement, the share of disability benefits in total spending is greater than 30 percent. In contrast, in France and Japan, disability pensions are granted under strict medical evaluations, and the share is less than 5 percent (Figure 2.1).

Figure 2.1.Composition of Public Pension Spending, 2007

More than three-quarters of public pension systems link benefits to lifetime earnings (Figure 2.2). These plans can be “defined benefit” (with pension benefits typically dependent on the number of years of contributions and the average of covered earnings) or “defined contribution” (with benefits dependent on the contribution history and the returns on these contributions). Some countries also offer a flat-rate component that does not depend on previous earnings, while others provide only a means-tested or flat-rate universal public pension (Australia, Iceland, New Zealand, Indonesia, Malaysia, South Africa). Access to means-tested benefits for the elderly (regardless of contribution history) is more common among advanced than emerging market economies—two-thirds of all plans in advanced economies have some sort of means-tested program targeting the elderly compared with fewer than half in the emerging market economies. Only four countries have a flat-rate universal pension (Canada, Denmark, New Zealand, Russia).

Figure 2.2.Characteristics of Mandatory Pension Plans

Sources: U.S. Social Security Administration; and IMF staff estimates.

Note: Figures do not add to 100 because a single system can have several characteristics.

Whereas nearly all emerging market economies in Europe and Latin America supplement their public pension systems with some type of mandatory private plans (mostly through systems of individual accounts), only two advanced economies do so (Slovak Republic, Sweden).2 A few emerging market economies in Asia (India, Indonesia, Malaysia) use “provident funds”—that is, a system of centrally managed individual accounts that typically provides lump-sum benefits. Some advanced economies (Australia, France, Iceland, Switzerland) also have mandatory occupational pensions with participation linked to employment or membership in a professional or trade group. Advanced economies often complement their public systems with voluntary private plans, including voluntary occupational plans. While in some countries, voluntary private pensions play almost no role in providing retirement income (Austria, Spain), in others—especially those in which the public pension comprises mainly a flat-rate component—they are vital (Australia, the Netherlands).3 Very few emerging market economies have sizable voluntary private pensions (see Table A5.1).

Box 2.1.Pension Systems: Pay-As-You-Go versus Funded

Pay-as-you-go systems use employer and employee contributions to pay for current benefits to the retired. Under funded systems, contributions are invested in assets with the objective of financing future retirement benefits. Most public arrangements are pay-as-you-go systems, although some have a degree of funding (Canada, the United States). In contrast, most private pensions are funded. In essence, pay-as-you-go and funding are both mechanisms through which retired people gain access to future production to support their consumption. In the case of pay-as-you-go pensions, this is done through a social contract between the generations (via the tax system). In the case of funded pensions, this is achieved through capital markets—workers invest and then sell the accumulated assets to the succeeding generation. Both are equally affected by demographics, though they might differ in terms of their implications for inter-generational equity and the credibility of the transfer mechanism over the long term (Barr, 2004). Funded systems, however, can break the link between domestic consumption and domestic output by allowing investment abroad.

For example, the increase in disability spending in Australia was largely associated with the recession of the early 1990s. Other factors included the curtailment of survivor pensions, the relaxation of eligibility criteria, and the increase in the age of retirement for women (Cai and Gregory, 2004). More recently, disability spending has continued to increase, reflecting benefit rates and the lack of job search requirements (Sun, 2011).

In emerging market economies mandatory private pensions were established over the past three decades and are not yet fully mature. Thus, private pension spending remains limited. For example, in Chile, which introduced private pensions in the 1980s, the share of these pensions in total pension spending is about one-quarter. Mandatory private pension plans can potentially contribute to more transparent capital markets, better corporate governance practices, improvements in financial innovation, and increased financial integration (Velculescu, 2011).